USD FMQ Carries on Growing Despite Tapering

June's FMQ components have now been released by the St Louis Fed, and it stands
at a record $13.132 trillion. As can be seen in the chart above, it is $5.48
trillion more than an extension of the pre-Lehman crisis exponential growth
trend. At this point readers not familiar with the construction of FMQ and
its purpose may wish to refer to the original paper, here.

It should be borne in mind that there may be seasonal factors at play, with
dips in the growth rate discernable at this time of year in the past. So the
slower growth rate of FMQ, up $44bn between April and June when it might have
risen $150-200bn, is not necessarily due to tapering of QE3. If tapering was
responsible for slowing growth in FMQ, we could expect to see some tightening
in short-term interest rates. But as the chart of 3-month T-bill rates shows
they have been in a declining trend since last November.

The chart confirms that tapering seems to be having little or no effect on
money markets and therefore the growth rate of fiat currency.

Weakness in interest rates is also consistent with poor economic demand. This
week the
first estimate of Q2 GDP was released which came in at an annualised 4%,
substantially above market estimates of 3.1%. This outturn conflicts sharply
with the lack of any meaningful demand for money, until one looks at the underlying
estimates.

Of this 4% increase, the change in real private inventories added 1.66%. In
other words GDP based on goods and services actually sold was only 2.34%. That
changes in unsold goods, which is what inventories represent, should be part
of final consumption is a dubious proposition, but need not concern us here.
According to the technical note accompanying the release, figures for inventories
and durable goods (which showed an incredible rise of 14%) are estimated and
not hard data, so are subject to future revision. On this basis, the surprise
GDP figure is little more than a government econometrician's guess until the
real data is available. Suspicions that these guesses err on the optimistic
side are confirmed by the experience of the Q1 GDP figure, which was revised
sharply downwards from first estimates when hard data eventually became available.

Whichever way we look at FMQ, it continues to expand at a frightening pace
irrespective of the GDP outturn and its flaws. Furthermore, a look at the most
recent Fed balance sheet confirms this view, showing that the 1st August figure
will be considerably higher, unless there is an offsetting contraction of bank
credit.

There is little sign of any such contraction. We can conclude from short-term
market interest rates that the US economy is going nowhere fast, contrary to
this week's GDP estimate, and that demand for credit continues to come from
essentially financial activities. But given that GDP estimates turn out to
be far too optimistic, what if the US economy stalls or even slumps? Won't
that lead to a reversal of FMQ's growth trend?

This is essentially the argument of the deflationists. In a slump they expect
a dash from credit into cash as asset prices tumble. The counterpart of credit
is deposits, the major components of FMQ. And without Fed intervention FMQ
would rapidly contract. But in the event of a slump the Fed cannot be expected
to stand idly by without taking extraordinary measures: in the words of Mario
Draghi at the ECB, whatever it takes.

Alasdair Macleod runs FinanceAndEconomics.org,
a website dedicated to sound money and demystifying finance and economics.
Alasdair has a background as a stockbroker, banker and economist. He is a
Senior Fellow at the GoldMoney
Foundation.

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